SEC shakes up funds' leadership

Despite intense opposition from many leaders in the mutual fund industry, a divided Securities and Exchange Commission on Wednesday approved a plan to require funds to have independent chairmen.

Commissioners voted 3-2 in favor of a wide-ranging proposal on fund governance, which included another controversial mandate: that at least 75 percent of directors on a board be independent.

The rules, prompted by recent scandals that have rocked the $7.5 trillion mutual fund industry, will take effect at the end of next year.

The U.S. has roughly 500 fund companies, and about 80 percent of their funds have chairmen who will have to step down, SEC officials said, including giants Fidelity and Vanguard.

In theory, such firms are hired by boards to manage the funds. But fund advisers, in reality, establish funds and essentially control the selection of directors.

Opponents said there was no proof that more independent directors or independent chairmen would improve fund performance or prevent wrongdoing.

Chairman William Donaldson broke with other Republican members to join the SEC's two Democrats in voting for the plan. He said the independent chairman rule was the "keystone" of a package designed to help shift the balance of power from the people who operate a fund to the directors who are supposed to oversee them.

"Fund shareholders want, and they have a right, to have their mutual funds managed in the interest of the fund shareholders, and for no one else," Donaldson said.

When funds have an independent chairman, the performance of independent directors as a group will improve, said Don Phillips, managing director of Chicago-based fund tracker Morningstar Inc., which supported the proposal.

"The essence of the problem is an absence of checks and balances," he said.

For years, Phillips said, fund managers have denigrated independent directors, saying, "`The hardest thing about independent directors is keeping them awake.' . . . It's awful that this is the way fund companies are talking about their boards."

Supporters said the new rules would have helped head off some of the industry's scandals and empowered independent directors, giving them leverage in negotiating the fund adviser's fees.

Republican Commissioner Paul Atkins said supporters were relying on "a hope and a prayer" in adopting the rules, which also require independent directors to meet separately at least four times a year and boards to assess their own performance. The rules also allow independent directors to hire their own staff.

"We appear to be more concerned with `doing something' and going with our gut feelings than we are concerned with making sure that what we do is right," Atkins said.

But Democrat Harvey Goldschmid called the rules "truly a historic achievement," saying "it simply is good sense" that greater independence on boards would lead to improved oversight of fund advisers.

Supporters noted that most of the mutual funds implicated in trading scandals did not have independent chairmen. But opponents said that simply reflects the makeup of the industry.

Republican Cynthia Glassman insisted that "legal independence does not equate with real independence" and said the rule will require shareholders to bear additional expenses from paying new chairmen and allowing them to hire a staff.

"The benefits are illusory, but the costs are real," she said.

Many fund industry leaders, including chairmen of the Vanguard and Fidelity funds, lobbied against the proposal.

The Investment Company Institute, the leading mutual fund trade group, also opposed it. The institute said again Wednesday that it supports much of the SEC's mutual fund agenda, but believes independent directors should be allowed to decide who makes the best fund chairman.

The seven living former SEC chairmen, however, supported the plan, along with scores of small investors who wrote commissioners to urge them to adopt it. "The proposals resonate strongly with individual mutual fund shareholders," Donaldson said.

Herbert Allison, chief executive of the giant TIAA-CREF teachers retirement system, called the vote "a major victory" for investors.

"The SEC's action affirms the basic principle that the people who buy fund shares own the funds," he said. "It also recognizes the inherent conflict of interest between fund investment managers, who profit from investor fees, and fund investors, who benefit from independent oversight."

Separately, commissioners unanimously approved a rule to require funds to improve disclosure of directors' decision-making in approving adviser contracts, including more specifics about costs, the quality of services and fund performance.